Unpicking the UK’s oil tax regime

After the outcry over the UK Government’s 2011 Budget £10billion tax grab, North Sea oil producers have been given a string of allowances to make their investments more viable. Aberdeen University’s professor of petroleum economics, Alex Kemp, unpicks the latest tax changes and argues that the debate over future additional allowances will continue

Since the March 2011 Budget there have been a succession of government announcements of field allowances.

They cover various types of oil and gas field, including small fields, stranded fields and brownfield investments. The details of the allowances appear rather complex and the question of their rationale is worthy of an explanation.

The North Sea’s oil tax system is essentially a flat-rate one, but it is applied to fields which vary enormously in size, cost per barrel and thus profitability. Oil companies have to meet investment hurdles before projects are sanctioned, including minimum post-tax profits and materiality.

This could mean a relatively small field might not offer sufficient materiality to satisfy a large investor with many other opportunities, especially when a tax rate is raised.

This was the background to the concerns of the industry following the 2011 supplementary charge increase, from 20% to 30%.

The new allowances have been the consequence. But why are they apparently so complex?

Apart from the most recent brownfield allowance, they are all related to physical characteristics of fields, including their location, rather than economic features.

Particular fields have been identified by investors as being sub-economic after tax, and the response of the government has been to incentivise their development through carefully structured allowances whose applicability is limited to fields known to be non-commercial.

There has been a determination to ensure that only projects which require tax relief to become economic shall obtain the allowances, to protect tax revenue from fields which pass the investment hurdle without further help.

The new brownfield allowance deserves special mention because it is based on investment costs. This should incentivise incremental recovery schemes widely, and is an overdue recognition of the importance of increasing the recovery factor; currently averaging only about 38% for oil fields on the UK continental shelf.

It is to be expected that further allowances will emerge in the future.

One obvious candidate for an allowance is CO2 enhanced oil recovery schemes, which do not qualify for the brownfield allowance. We can thus expect the debate to continue.